Despite many years of research, the evidence on market efficiency described in this chapter appears to be inconclusive. Some argue that this is because researchers have been unable to link company fundamentals to stock prices precisely. Comment

Answer 1

Evidence on market efficiency comes primarily from studies that show how stock prices change with the announcement of new public information. In general, these studies show that stock prices change quickly with these announcements, implying a high level of efficiency. However, more recent efficient markets research suggests that this conclusion may be premature. This research finds, for example, that earnings information is not completely impounded into price for several quarters, a significant departure from the notion of a highly efficient market.
The primary difficulty in interpreting the evidence on market efficiency is that the empirical tests are joint tests of market efficiency with a particular asset pricing model. The abnormal returns generated by trading strategies based on firm size and price-to-earnings ratios, for example, may therefore reflect the omission of important sources of risk from the pricing model used to generate the abnormal returns, rather than a market inefficiency.